Disclaimer: Please note that the material presented herein is provided solely for informational purposes and should not be construed as, or relied upon as professional tax advice. No tax position should be undertaken or altered based on the information contained herein. We do not assume responsibility for any reliance placed on this information.
In cases involving specific incomes or transactions, it is highly recommended to conduct an extensive individual analysis, considering all relevant circumstances.
Additionally, the proposed legislative amendments referred to in this document were pending adoption at the time of its drafting and publishing, and were subject to ongoing discussions in the Parliament. Hence, the rules outlined and their interpretation by authorities may undergo modifications in response to finalized provisions coming into effect.
On July 8, 2022, the US announced that it will terminate the double taxation treaty concluded with Hungary in 1979. The reason for the termination was that the 1979 bilateral tax treaty no longer provided mutual benefits due to tax changes in both countries. The provisions of the treaty will not be applicable after January 1, 2024. Below, we present the implications of the change, in which we will focus on the Hungarian tax legislation.
What will happen after 1 January?
- The treaty was a point of alignment in the US-Hungarian economic relations.
- The treaty introduced a single system of definitions and specified exactly which countries could levy taxes on what income.
- It has significantly limited the imposition of withholding taxes and introduced a single set of rules to eliminate double taxation (exemption/tax credit).
- The treaty will cease to have effect from January 1, 2024, which is already indicated in the draft act amending the tax rules. This means that the provisions of the treaty will apply for the last time to the income paid or occurred up to 2023, after which the rules of each country's domestic law will apply.
- Although the legal system of both countries allows the credit of the tax already paid abroad in certain cases and to a certain extent, these rules alone are unlikely to be sufficient to replace the treaty.
What impact will the absence of the treaty have on the new agreements?
- The treaty will no longer apply to agreements concluded after January 1, 2024.
- For withholding tax, the provisions of national law will apply to the payments and to the avoidance of double taxation.
- For income tax, it will not apply for the tax years starting after January 1, 2024.
What impact will the absence of the treaty have on existing agreements?
- For agreements already in force, the time of the payment or the time when the income/profit occurred should be examined to determine whether the tax treaty applies.
Who will be affected and how will they be affected by the termination of the treaty?
How will it affect US citizens living in Hungary?
- The treaty determined the state in which a person has tax residency. In the absence of a treaty, the tax status of US citizen expats living in Hungary must be determined (in parallel) based on the Hungarian Personal Income Tax Act as well as based on the US tax rules. Thus, an individual can be tax resident in both countries.
- On the other hand, non-resident individuals also have a limited tax liability in respect of income derived domestically. Thus, such individuals are subject to taxation on their activity carried out in Hungary.
- Thirdly, the exemption/credit mechanism under the treaty will be ceased to apply, so that Hungarian tax payments will have to be taken into account under US domestic law, and the US tax liability will be taken into account under Hungarian law
- The significant US withholding tax may also negatively affect US passive income earners with Hungarian tax residence. In addition to the 30% US withholding tax, a 5% Hungarian personal income tax liability may also incure, resulting in a total burden of 35%.
- The autumn tax package tightens the rules on tax credit: for income earned domestically, the above withholding tax does not seem to be creditable for income subject to separate and consolidated taxation.
- On this issue, another significant change in the autumn tax package is the clarification of the rules on where the performers and sportsmen and sportswomen earn their income. The amending provision would extend the right of Hungary’s taxation from January 1, 2024, in line with most of the double taxation treaties concluded by Hungary. Accordingly, under domestic law, Hungary may tax the income derived from the activity carried out domestically, even if the income is not derived by the individual but by another person (for example, if the individual carries out his activity under contract through his or her company).
How will it affect Hungarian citizens living in the US?
- Hungarian citizens working or living in the US for a longer period - without dual citizenship - will not lose their Hungarian tax residency in the absence of the treaty. This may result in their income remaining taxable in Hungary, as well.
- So far, the treaty has determined the applicable credit/exemption mechanism. In cases of double taxation, exemptions were available for consolidated taxable income and credit for dividend income from the US.
- From January 1, 2024, under Hungarian rules, 90% of the foreign tax liability can be credited from the consolidated tax base. Under the autumn tax package, this rule will be stricter and will not apply to income considered to be earned domestically. Concerning incomes separately taxable (e.g. dividend, interest) in Hungary, the payable tax cannot be less than 5% of the tax base due to the credit of the tax paid abroad, and the crediting rules will be tightened in this case too. In case of income earned in the country, tax paid abroad is expected to be credited.
What will be the impact on Hungarian-based businesses?
- The US levies a significant withholding tax of 30% on payments to non-treaty countries.
What will be the impact on services from Hungary to the US?
- In the absence of a treaty, fees for services provided from Hungary to the US may also be subject to a 30% withholding tax (generally speaking, if the fee is related to a trade or business activity in the US (effectively connected income, or ECI), no withholding tax will be levied - but we recommend to consult a US tax advisor to check specific cases).
What will be the impact on operations through the US subsidiary?
- Under the treaty, the US has so far been able to levy withholding tax only on dividends, at a maximum rate of 15%.
- As withholding tax is levied on payments, any payments directed to Hungary through subsidiaries may be subject to the 30% withholding tax, in particular dividends, branch profits, interest, royalties, technical fees, management fees.
What will be the impact on US companies operating in Hungary?
- The uncertainty and long-term unpredictability caused by the absence of the treaty will of course have a negative impact on companies in both countries. However, in the short term, the termination of the treaty will have less negative impact on US companies operating in Hungary. Hungary does not impose withholding tax on payments to companies.
What will be the impact on services provided directly from the US?
- Hungary currently does not levy withholding tax on service fees paid to the US, so services received directly from the US will not be negatively affected in the short term by the termination of the treaty.
What will be the impact on operations through a Hungarian subsidiary?
- If a US company sells a directly held subsidiary with real estate assets in Hungary (or reduces its capital), the realized gain may also be subject to a Hungarian corporate income tax of 9%.
- This is typically creditable against US tax liabilities, but we recommend consulting US tax advisors to interpret US tax law.
Which incomes will be affected for companies?
What can be subject to withholding tax?
- The US imposes a 30% withholding tax on dividends, branch profits, interest, royalties, technical fees, management fees. For services, payments that qualify as effectively connected income may be exempted from withholding tax, but we recommend consulting a US tax advisor for detailed rules.
How do the rules change on permanent establishments in Hungary and in the US?
- Until now, the treaty has been used to determine whether a permanent establishment (“PE”) has been established in the respective country. This will also change from 2024 and will now need to be determined under domestic law.
- Currently, the income of Hungarian companies attributable to a US PE is exempted from Hungarian corporate income taxation (“CIT”). From 2024, the income of the US PE may be subject to CIT, against which 90% of the US tax may be credited. The provision of services will also give rise to the application of the PE rules under Hungarian domestic law, which may result in a tax liability in Hungary.
- Income attributable to the Hungarian PE of a US company is taxable under Hungarian corporate tax.
- We recommend consulting a local tax advisor to assess the risks of a US PE.
What are the tax credit rules in Hungary and the US?
- Under the Hungarian CIT Act, 90% of the US withholding tax can be credited against the Hungarian CIT, but the amount of the credit cannot exceed the average tax on the respective income.
- The US federal tax rules also resolve the double taxation for US taxpayers through the Foreign Tax Credit (FTC) and the tax deduction. We recommend consulting a US tax advisor for the exact rules.
Which incomes will be affected in case of private individuals?
How is tax residency determined in Hungary and in the US?
- A private individual has Hungarian tax residency:
- if he/she is a Hungarian citizen (unless they are also a citizen of another country and do not have a registered address in Hungary);
- who exercises the right of free movement and residence in the territory of Hungary for at least 183 days in a given calendar year, counting the day of entry and exit as a whole day;
- a person with a settled status or stateless person;
- a natural person not mentioned in the previous points, who
- have their permanent home available exclusively in the country;
- has its centre of vital interests in the country, if they have no permanent home available in the country or has that in another country as well;
- has a habitual abode in the country, if they have no permanent home available in Hungary or they have that not only in Hungary, and the centre of vital interest cannot be established; (with the provision that the centre of vital interests is the state with which the individual has the closest personal, family and economic ties, and the permanent home available is the place where the individual has settled down to live permanently and actually resides. Permanent home available does not change if the individual is temporarily abroad for a longer period.)
- We recommend consulting a US tax advisor to determine your US tax liability. Generally speaking, US citizens are US tax residents. Foreign citizens become tax residents if they are a permanent resident (i.e., if they have a U.S. green card) or if they meet the substantial presence test.
What are the differences between the taxation of Hungarian source income and US source income?
- Hungary can levy withholding tax on any payment to a private individual.
- As discussed earlier, the US imposes a wide range of withholding taxes.
- These withholding taxes can be credited against Hungarian personal income tax, but the rules of crediting will change according to the autumn tax package. Crediting will not be available to income considered to be earned in Hungary in case of Hungarian tax residents.
- The credit rules for incomes in the consolidated tax base would also change accordingly, whereby - similar to US practice – the foreign tax would not be taken into account as if it was levied and paid in respect of income earned domestically.
- If the place of source of income is Hungary, there is a limited tax liability for non-residents (i.e. Hungarian sourced incomes are taxable in Hungary).
- We understand that the taxation of US-sourced income for non-residents is territorial, but we also recommend consulting US tax advisors.
- In addition, the taxation of US-sourced income in Hungary would be negatively affected from 2024. In some cases, the legislator wants to mitigate these negative changes:
- Interest from a country with which Hungary has not concluded a tax treaty is considered other income under the current rules. Other income includes dividends and exchange gains from a company based in a low-tax state. Under the autumn tax package, this provision will not be applicable if the source of the income is an OECD member state.
- Similarly, the legislator would extend the concept of a controlled capital market transaction, under which a transaction would be a controlled capital market transaction even if it is carried out with the involvement of an investment service provider operating in a state with which Hungary does not have a double taxation treaty but is an OECD member state.
What are the rules for tax credits in Hungary and the US?
- For domestic tax residents:
- From January 1, 2024, under Hungarian rules, 90% of the foreign tax liability can be credited against the consolidated tax base. Under the autumn tax package, this rule will be tightened and will not apply to income earned domestically.
- For separately taxable incomes (e.g. dividends, interests) in Hungary, the tax payable cannot be less than 5 percent of the tax base due to the credit of tax paid abroad, and the credit rules will be tightened in this case too.
- In the case of foreign tax resident individuals, if the source (“kifizető”) deducts the Hungarian tax liabilities, a US tax credit is available. For detailed information, please consult a US tax advisor.
Outlook for the future
When does the current treaty expire?
- For income taxes, its provisions will no longer apply for tax years starting in 2024.
- For withholding taxes, its provisions will no longer apply to amounts paid or credited in 2024.
What is the status of the 2010 treaty?
- So far, only Hungary has ratified this treaty, the US have not. Since then, as far as we know, major tax reforms have been made in the US, so this treaty is now considered "obsolete" and is not expected to be ratified.
What would be the process for negotiating a new treaty?
- A new treaty is preceded by lengthy bilateral negotiations to produce a text acceptable for both parties, which is then signed by representatives of the countries authorised to sign. It then needs to be ratified by the legislatures in both the US and Hungary legislation. Such processes typically take several years.